Avoiding Boot When Funding Cash Reserves in Exchange Transactions

It is often assumed that if a taxpayer receives cash in a tax-free exchange, the cash must be boot. It can be quite frustrating when a replacement property-lender requires that reserves be funded at closing, and funding those reserves with cash creates taxable boot. Strategies that fund the reserves without creating taxable boot are discussed below.

In the "black box" approach to exchange transactions, the taxpayer throws real estate and a new loan into the accommodator's black box and receives back real estate, the payoff of the old loan on the relinquished property, and perhaps a few other assets such as funded reserves. The bank often requires these reserves in order to pay for identified repairs to the property or to fund operating deficits. Since the funded cash reserves are not real estate, they are not like kind to the relinquished property and thus must be boot.